Definition of Call Option

Call Option

A contract that gives the holder the right to buy an asset for a
specified price on or before a given expiration (maturity) date

Call option

An option contract that gives its holder the right (but not the obligation) to purchase a specified
number of shares of the underlying stock at the given strike price, on or before the expiration date of the
contract.
call premium
Premium in price above the par value of a bond or share of preferred stock that must be paid to
holders to redeem the bond or share of preferred stock before its scheduled maturity date.

call option

Right to buy an asset at a specified exercise price on or before the exercise date.

Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).

Call an option

To exercise a call option.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Bull spread

A spread strategy in which an investor buys an out-of-the-money put option, financing it by
selling an out-of-the money call option on the same underlying.

Callable

A financial security such as a bond with a call option attached to it, i.e., the issuer has the right to
call the security.

Conversion ratio

The number of shares of common stock that the security holder will receive from
exercising the call option of a convertible security.

Covered call

A short call option position in which the writer owns the number of shares of the underlying
stock represented by the option contracts. Covered calls generally limit the risk the writer takes because the
stock does not have to be bought at the market price, if the holder of that option decides to exercise it.

Covered call writing strategy

A strategy that involves writing a call option on securities that the investor
owns in his or her portfolio. See covered or hedge option strategies.

Delta

Also called the hedge ratio, the ratio of the change in price of a call option to the change in price of the
underlying stock.

Forced conversion

Use of a firm's call option on a callable convertible bond when the firm knows that the
bondholders will exercise their option to convert.

Hedging

A strategy designed to reduce investment risk using call options, put options, short selling, or futures
contracts. A hedge can help lock in existing profits. Its purpose is to reduce the volatility of a portfolio, by
reducing the risk of loss.

In-the-money

A put option that has a strike price higher than the underlying futures price, or a call option
with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures
contract is trading at $6 an ounce, a March call with a strike price of $5.50 would be considered in-the-money
by $0.50 an ounce.
Related: put.

Limited-liability instrument

A security, such as a call option, in which the owner can only lose his initial
investment.

Long run

A period of time in which all costs are variable; greater than one year.
Long straddle A straddle in which a long position is taken in both a put and call option.

Limited-liability instrument

A security, such as a call option, in which the owner can only lose his initial investment.

Long straddle

A straddle in which a long position is taken in both a put and call option.

Naked option strategies

An unhedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying
put options ), and short put strategy (selling or writing put options). By themselves, these positions are called
naked strategies because they do not involve an offsetting or risk-reducing position in another option or the
underlying security.
Related: covered option strategies.

Option

Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a
given date. Investors, not companies, issue options. Investors who purchase call options bet the stock will be
worth more than the price set by the option (the strike price), plus the price they paid for the option itself.
Buyers of put options bet the stock's price will go down below the price set by the option. An option is part of
a class of securities called derivatives, so named because these securities derive their value from the worth of
an underlying investment.

Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of
the underlying security.

Right

A short-lived (typically less than 90 days) call option for purchasing additional stock in a firm, issued
by the firm to all its shareholders on a pro rata basis.

Uncovered call

A short call option position in which the writer does not own shares of underlying stock
represented by his option contracts. Also called a "naked" call, it is much riskier for the writer than a covered
call, where the writer owns the underlying stock. If the buyer of a call exercises the option to call, the writer
would be forced to buy the stock at market price.

Warrant

A security entitling the holder to buy a proportionate amount of stock at some specified future date
at a specified price, usually one higher than current market. This "warrant" is then traded as a security, the
price of which reflects the value of the underlying stock. Warrants are issued by corporations and often used
as a "sweetener" bundled with another class of security to enhance the marketability of the latter. Warrants are
like call options, but with much longer time spans -- sometimes years. In addition, warrants are offered by
corporations whereas exchange traded call options are not issued by firms.

Option

See call option and put option

Callable bond

A bond that allows the issuer to buy back the bond at a
predetermined price at specified future dates. The bond contains an embedded
call option; i.e., the holder has sold a call option to the issuer. See Puttable
bond.

Implied volatility

For an option, the variance that makes a call option price
equal to the market price. Given the option price, strike price, and other
factors, the Black-Scholes model computes implied volatility.

Straddle

A strategy used in trading options or futures. It involves
simultaneously purchasing put and call options with the same exercise price
and expiration date, and it is most profitable when the price of the underlying
security is very volatile.

Strike

Exercise a put or call option.

qualified investments (Canada)

Qualified investments is the term used for investments that can be held in an RSP. These investments generally include:
Canadian dollar savings accounts, guaranteed investment certificates, term deposits
shares of Canadian and foreign companies listed on a prescribed stock exchange
shares of some over-the-counter U.S. and Canadian companies
shares of some small businesses
certain types of bonds and money-market investments such as treasury bills, Canada Savings Bonds, Government of Canada bonds, provincial government bonds, Crown Corporation bonds, bonds issued by Canadian corporations listed on a prescribed stock exchange, and certain strip bonds
certain types of mortgages, including your own
certain covered call options, warrants and rights
certain mutual funds

Abandonment option

The option of terminating an investment earlier than originally planned.

American option

An option that may be exercised at any time up to and including the expiration date.
Related: European option

American-style option

An option contract that can be exercised at any time between the date of purchase and
the expiration date. Most exchange-traded options are American style.

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Asian option

option based on the average price of the asset during the life of the option.

Bargain-purchase-price option

Gives the lessee the option to purchase the asset at a price below fair market
value when the lease expires.

Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of
other options. These are very exotic options.

Basket options

Packages that involve the exchange of more than two currencies against a base currency at
expiration. The basket option buyer purchases the right, but not the obligation, to receive designated
currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of
exchange. A basket option is generally used by multinational corporations with multicurrency cash flows
since it is generally cheaper to buy an option on a basket of currencies than to buy individual options on each
of the currencies that make up the basket.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Call

An option that gives the right to buy the underlying futures contract.

Call date

A date before maturity, specified at issuance, when the issuer of a bond may retire part of the bond
for a specified call price.

Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.

Call price

The price, specified at issuance, at which the issuer of a bond may retire part of the bond at a
specified call date.

Call price

The price for which a bond can be repaid before maturity under a call provision.

Call protection

A feature of some callable bonds that establishes an initial period when the bonds may not be
called.

Call provision

An embedded option granting a bond issuer the right to buy back all or part of the issue prior
to maturity.

Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.

Call swaption

A swaption in which the buyer has the right to enter into a swap as a fixed-rate payer. The
writer therefore becomes the fixed-rate receiver/floating rate payer.

Compound option

option on an option.

Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies

Currency option

An option to buy or sell a foreign currency.

Dealer options

Over-the-counter options, such as those offered by government and mortgage-backed
securities dealers.

Deferred call

A provision that prohibits the company from calling the bond before a certain date. During this
period the bond is said to be call protected.

Delivery options

The options available to the seller of an interest rate futures contract, including the quality
option, the timing option, and the wild card option. Delivery options make the buyer uncertain of which
Treasury Bond will be delivered or when it will be delivered.

Doubling option

A sinking fund provision that may allow repurchase of twice the required number of bonds
at the sinking fund call price.

Down-and-in option

Barrier option that comes into existence if asset price hits a barrier.

Down-and-out option

Barrier option that expires if asset price hits a barrier.

Effective call price

The strike price in an optional redemption provision plus the accrued interest to the
redemption date.

Elasticity of an option

Percentage change in the value of an option given a 1% change in the value of the
option's underlying stock.

Embedded option

An option that is part of the structure of a bond that provides either the bondholder or
issuer the right to take some action against the other party, as opposed to a bare option, which trades
separately from any underlying security.

Equity options

Securities that give the holder the right to buy or sell a specified number of shares of stock, at
a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.

European option

option that may be exercised only at the expiration date. Related: american option.

European-style option

An option contract that can only be exercised on the expiration date.

Exercising the option

The act buying or selling the underlying asset via the option contract.

First-call

With CMOs, the start of the cash flow cycle for the cash flow window.

Foreign currency option

An option that conveys the right to buy or sell a specified amount of foreign
currency at a specified price within a specified time period.

Futures option

An option on a futures contract. Related: options on physicals.

Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

Greenshoe option

option that allows the underwriter for a new issue to buy and resell additional shares.

Implied call

The right of the homeowner to prepay, or call, the mortgage at any time.

Index and Option Market (IOM)

A division of the CME established in 1982 for trading stock index
products and options. Related: Chicago Mercantile Exchange (CME).

Index option

A call or put option based on a stock market index.

Intrinsic value of an option

The amount by which an option is in-the-money. An option which is not in-themoney
has no intrinsic value. Related: in-the-money.

Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill

Lookback option

An option that allows the buyer to choose as the option strike price any price of the
underlying asset that has occurred during the life of the option. If a call, the buyer will choose the minimal
price, whereas if a put, the buyer will choose the maximum price. This option will always be in the money.

Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill Lynch & Co.

Margin call

A demand for additional funds because of adverse price movement. Maintenance margin
requirement, security deposit maintenance
Margin of safety With respect to working capital management, the difference between 1) the amount of longterm
financing, and 2) the sum of fixed assets and the permanent component of current assets.

Margin requirement (Options)

The amount of cash an uncovered (naked) option writer is required to
deposit and maintain to cover his daily position valuation and reasonably foreseeable intra-day price changes.

Multi-option financing facility

A syndicated confirmed credit line with attached options.

Option elasticity

The percentage increase in an option's value given a 1% change in the value of the
underlying security.

Option not to deliver

In the mortgage pipeline, an additional hedge placed in tandem with the forward or
substitute sale.

Option premium

The option price.

Option price

Also called the option premium, the price paid by the buyer of the options contract for the right
to buy or sell a security at a specified price in the future.

Option seller

Also called the option writer , the party who grants a right to trade a security at a given price in
the future.

Option writer

option seller.

Option-adjusted spread (OAS)

1) The spread over an issuer's spot rate curve, developed as a measure of
the yield spread that can be used to convert dollar differences between theoretical value and market price.
2) The cost of the implied call embedded in a MBS, defined as additional basis-yield spread. When added to the
base yield spread of an MBS without an operative call produces the option-adjusted spread.

Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not
the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a
specified time period, or on a specified date (expiration date).

Options contract multiple

A constant, set at $100, which when multiplied by the cash index value gives the
dollar value of the stock index underlying an option. That is, dollar value of the underlying stock index = cash
index value x $100 (the options contract multiple).

Options on physicals

Interest rate options written on fixed-income securities, as opposed to those written on
interest rate futures contracts.

Path dependent option

An option whose value depends on the sequence of prices of the underlying asset
rather than just the final price of the asset.

Postponement option

The option of postponing a project without eliminating the possibility of undertaking it.

Provisional call feature

A feature in a convertible issue that allows the issuer to call the issue during the noncall
period if the price of the stock reaches a certain level.

Put an option

To exercise a put option.

Put option

This security gives investors the right to sell (or put) fixed number of shares at a fixed price within
a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain
price by a certain time in order to protect, or hedge, an existing investment.

Put-call parity relationship

The relationship between the price of a put and the price of a call on the same
underlying security with the same expiration date, which prevents arbitrage opportunities. Holding the stock
and buying a put will deliver the exact payoff as buying one call and investing the present value (PV) of the
exercise price. The call value equals C=S+P-PV(k).

Quality option

Also called the swap option, the seller's choice of deliverables in Treasury Bond and Treasury
note futures contract. Related: cheapest to deliver issue

Split-fee option

An option on an option. The buyer generally executes the split fee with first an initial fee,
with a window period at the end of which upon payment of a second fee the original terms of the option may
be extended to a later predetermined final notification date.

Stock index option

An option in which the underlying is a common stock index.

Stock option

An option in which the underlying is the common stock of a corporation.

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